Reducing Inflation with More Inflation

The Inflation Reduction Act recently passed by the Senate is an act of economic and financial illiteracy one would tend to associate with Argentine politicians, not with the Parliament of the world´s only superpower. The Senate Majority Leader has characterized it as “a legislative feat of the 21st century.” One wonders what he was smoking. Or perhaps he was right and this will become a lasting paradigm of U.S. politicians’ inability to learn any of the lessons of the last hundred years.

To begin with, any law destined to combat inflation that is 755 pages long is an affront to common sense. Its provisions aim to curb inflation by raising public spending on a colossal scale; needless to say, the Fed will need to “print” tons more money to cover the fiscal bill. The bright idea, then, is to fight what was caused by a massive fiscal and monetary expansion with...a massive fiscal and monetary expansion. It is similar to what politicians did in the aftermath of the financial crisis of 2007/8 and in the wake of the Covid pandemic two years ago.

Why would the consequences be different this time? 

The Congressional Budget Office projects that, as things stand today, revenues would add up to a total of $56.5 trillion in the next decade, but spending would surpass that mark by $15.7 trillion, a cumulative deficit greater than the size of China’s economy (about $1 trillion bigger). This is assuming that the U.S. economy will grow healthily next year, and the next, and so on, with no recession in sight within the next decade, so that the cumulative GDP will add up to $311.6 trillion—and also assuming that inflation will come down to 2.3 percent next year (using the PCE deflator). 

Even if these grotesque assumptions proved to be true, the anti-inflation bill passed by Congress in order to tame the projected deficit will only reduce it by the equivalent of 0.1 percent of GDP over the decade. 

It contemplates $485 billion of additional spending and tax breaks (the lion’s share is spending), mostly on clean energy (no consideration for the effects that clean energy regulations have had on the price of energy in recent years by inhibiting investment in oil, gas and other sources, thereby limiting their supply) and on health care.

To offset this, the bill assures us that new revenue and savings will add up to $790 billion. Even if the projection proved accurate, the end result would hardly impact the current trajectory of the deficit. But it seems highly unlikely that the projection will prove to be correct given where the savings and the extra revenue are supposed to come from. For instance, a provision for “Tax Enforcement Funding” promises to obtain $124 billion by doubling the number of IRS agents—the idea being that for every dollar spent hiring new agents the government would obtain $2.55 dollars of extra revenue. Why not quintuple the number of agents and resolve the deficit altogether? Good luck with that! 

No wonder every organization that looked at this Alice-in-Wonderland bill reached the conclusion that it is a recipe for more inflation. The Tax Foundation, a nonprofit that advises governments, estimates that the Inflation Reduction Act will reduce economic output by 0.1 percent and eliminate 30,000 full-time equivalent jobs in the U.S. It will also reduce average taxpayers’ income across the board. A reduction in the economy’s capacity to produce goods and services will mean less revenue, more deficits. Exactly how does this lead to lower inflation?

We have entered an era of high inflation; by every indication, it is here to last—courtesy of Washington.

Alvaro Vargas Llosa is a Senior Fellow at the Independent Institute. His Independent books include Global Crossings, Liberty for Latin America, and The Che Guevara Myth.
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